Competition Gets a Pat on the Back
People who favor a commercial approach to microfinance and people who oppose interest rate caps have argued for years that competition would bring meaningful reductions in microcredit interest rates. Others have been skeptical about this prediction. A new study by Guillermo Baquero, Malika Hamadi, and Andreas Heinen seems to shed considerable light on this question. The study uses a comprehensive data set including not only MIX Market information but also data on 329 microlenders provided by three rating agencies, for a total of 1335 institutions.
The headline finding is that increased competition in a country is associated with substantial declines in interest rates. Interestingly, this effect is driven by for-profit lenders; the study found a much smaller correlation between competition and changes in non-profit rates.
In for-profit institutions, the size of the effect is surprising. The opposite of competition is market concentration, typically measured by the Herfindahl Hirschman Index (HHI). If a given country moves from the 90th percentile on the distribution of HHIs down to the 50th percentile (i.e., the industry is becoming less concentrated, more competitive) the associated drop in the interest rate is almost eight percentage points. This is about triple the rate decrease reported in studies of the regular commercial banking sector. Competition seems to work better in microfinance than in conventional finance. Of course, these are average results. They did not mean that interest rates will decline in every microcredit market that becomes more competitive.
A second question is whether loan delinquency will get worse as competition increases. Does the availability of multiple lenders increase over-indebtedness? The study finds no empirical support for this proposition. There is actually some evidence that loan repayment in for-profit institutions will be better as competition increases.
Does this mean that we don’t need to be so worried about over-indebtedness in more advanced markets? Not really. Competition has to do with the number and relative market power of providers. Market saturation is a different issue: how close is the supply to catching up with the demand for microloans? Adrian Gonzalez reports that when loans-per-population (a proxy for saturation) exceeds 10%, delinquency and default are higher.
Putting all these results together, competition comes out looking like a pretty good thing. It’s market saturation (rather than competition or growth rates) that seems to be associated with repayment problems.